Re-inflating the bubble

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We never learn... beware the high yield debt markets...

From "The Big One: Bankers expect Megabuyout" in the WSJ by Peter Lattman

A private-equity deal Tuesday to acquire financial market data provider Interactive Data Corp. for $3.4 billion is one of the clearest signs yet of private equity's renewed potency.

The buyers, Silver Lake Partners and Warburg Pincus, secured more than $2 billion worth of loans from four large banks, according to people familiar with the deal. The debt financing is being offered at roughly than six times the company's earnings before interest taxes, depreciation and amortization, a leverage level among the highest since 2007.

Silver Lake and Warburg are also paying up for the Bedford, Mass., company, which has a relatively stable subscription-based business that holds great appeal to private-equity firms. The buyers are acquiring the business for 12.1 times its 2009 Ebitda of $281 million. This is the highest acquisition multiple since 2008, wrote S&P in a research note Wednesday, "a clear data point on the road toward expanding multiples."

But another element of the Interactive debt package reflects a more-conservative lending environment. Roughly $1.4 billion, or about 41%, of the purchase price for Interactive Data will come from the buyers' equity. Some large boom-era deals--such as the leveraged buyout of Clear Channel--had as little as 10% to 20% equity contributed to a deal.

For the uninitiated: If a company makes $100 a year from selling for more than it costs to make, that's essentially your EBITDA.

A 12.1x multiple means the company would have cost $1,210.

With a 6x senior leverage ratio, that's $600 borrowed.

If 41% of the purchase price comes from buyers equity, that's $500 of equity.

This implies $110 of additional 'sub debt', putting the actual debt level on the company at 7.1x EBITDA.

Assuming market rates on the senior debt (let's say LIBOR + 5% with a LIBOR floor of 2%, or 7%), the Senior debt interest burden is 7% * 600 = $42/year.

Assuming market rates on the sub debt of LIBOR + 15% (17%), the sub debt interest burden is 17% * 110 = $19/year

Now let's examine our cash flow. The $100 we earned annually was before paying our interest payments, so 100 - 42 - 19 = $39/ year. From the $39, we have to pay approximately 40% taxes, so subtract out another $16 and you're left with $23 a year to reinvest in the company (capital expenditures) and pay down debt. If you assume a 5% CapEx run rate, which is in the neighborhood of appropriate, you're left with $18 a year for debt repayment.

Remember, we have $710 of total debt, so assuming no growth (and no contraction), the debt would be repayed in approximately 40 years. (Not that the debt will ever actually be paid off... it will just be refinanced the next time an I-Banker convinces the CEO it's time to refi.)

Another major risk? Well LIBOR is at historically low rates. As LIBOR moves above 2%, the interest payments would increase $7/year for every percentage point above 2%. LIBOR was at 5.5% as recently as 2007, and interest rates will likely skyrocket as governments across the globe are forced to either increase rates to avoid inflation... or as the markets demand an increased rate as the global currencies begin to inflate. Regardless, the above cash flow scenario is a best-case-scenario when considering interest rates.

Is this deal doomed to fail? Not necessarily. But it's got a ton of debt on it, and there's not all that much room for error from the company. As someone who regularly reviews capital structures of LBOs, I'll say that a 12.1x valuation is high... and when I see a company with a 7.1x debt multiple... well, we're usually rather uneasy about that. Seeing these numbers at the onset of a deal... well... I sure hope the company is as steady as it's been described to be.